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A Manifesto for Economic Sense

More than four years after the financial crisis began, the world's major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.

These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.

  • The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions - other than Greece - this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
  • The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but - just like the similar response of debtors in the 1930s - it has proved collectively self-defeating, because one person's spending is another person's income. The result of the spending collapse has been an economic depression that has worsened the public debt.
  • The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that's exactly what many governments are now doing.
  • The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn - focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing and exacerbating the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy - while it should do all it can - cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.

The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.

But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.

Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMF's study is clear - budget cuts retard recovery. And that is what is happening now - the countries with the biggest budget cuts have experienced the biggest falls in output.

For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.

So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.

The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side - by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.

In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.

As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.

Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at, and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.

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Signed By

Aaron Goldzimer - Stanford Graduate School of Business / Yale Law School
Alan Manning - London School of Economics
Alan Maynard - University of York
Alan S. Blinder - Princeton University
Alasdair Smith - University of Sussex
Alfonso Lasso de la Vega - Former Deputy Director in UNCTAD
Ali Rattansi - Professor, City University, London
Andrew Graham - Oxford University
Barbara Petrongolo - Queen Mary University and CEP (LSE)
Barbara Wolfe - University of Wisconsin-Madison
Barry Bluestone - Northeastern University
Barry Supple - University of Cambridge
Charles Wyplosz - The Graduate Institute, Geneva
Chris Pissarides - London School of Economics and Political Science
Christian Kroll - University of Bremen / Jacobs University
Christopher Allsopp - Director, Oxford Insitute for Energy Studies, Oxford
Colin Thain - University of Birmingham, UK
David Blanchflower - Dartmouth College
David Hemenway, economist - Harvard School of Public Health
David Sapsford - Edward Gonner Professor of Applied Economics (Emeritus), University of Liverpool
David Soskice - University of Oxford
David Vines - Oxford University
Demetrios Papathanasiou - The World Bank
Donald R. Davis - Columbia University, Dept. of Economics
Eric van Wincoop - University of Virginia
Erzo F.P. Luttmer - Dartmouth College
G C Harcourt - University of New South Wales, School of Economics
Gary Mongiovi - St Johns University, New York
Geoffrey M. Hodgson - Professor, University of Hertfordshire, UK
Geraint Johnes - Lancaster University
Gianni Zanini - World Bank (Consultant; former Lead Economist)
Hannes Schwandt - CEP/LSE and Universitat Pompeu Fabra
Heinz Kurz - University of Graz, Austria
J. Bradford DeLong - U.C. Berkeley
Jan-Emmanuel De Neve - University College London & LSE Centre for Economic Performance
Jeffrey Frankel - Harvard University
Jeremy Hardie - LSE Centre for Philosophy of Natural and Social Science
Joan Costa Font - London Sschool of Economics
Jocelyn Boussard - European Commission
John H Bishop - Cornell University
John Van Reenen - Centre for Economic Performance, LSE
Jonathan Portes - National Institute of Economic and Social Research
Joseph Gagnon - Peterson Institute for International Economics
Justin Wolfers - Princeton University
Kalim Siddiqui - Business School, University of Huddersfield, UK
Ken Coutts - Faculty of Economics, University of Cambridge
Kevin ORourke - University of Oxford
Larry L Duetsch - Emeritus Prof of Econ, U of Wisconsin - Parkside
Lesley Potters - European Commission
Marcus Miller - Warwick University
Mariana Mazzucato - University of Sussex
Mark Setterfield - Trinity College, Connecticut
Mark Stewart - Warwick University
Max Steuer - London School of Economics
Michael Ambrosi - Professor Emeritus, University of Trier
Michael Graff - ETH Zurich and Jacobs University Bremen
Michael Waterson - University of Warwick
Nathan Cutler - Harvard Kennedy School
Nattavudh Powdthavee - University of Melbourne and Centre for Economic Performance, London School of Economics and Political Sciences
Nicholas Rau - University College London
Olaf Storbeck - Handelsblatt - Germanys Business and Financial Daily
Oriana Bandiera - London School of Economics
P.E. - Emeritus Professor of Economics,University of Reading
Patricia Rice - University of Oxford
Paul Anand - Open University/ HERC Oxford University
Paul Gregg - Professor, Dept of Social and Policy Sciences, University of Bath
Paul Krugman - Princeton University
Peter E. Earl - University of Queensland
Peter Elias - University of Warwick
Peter J. Hammond - University of Warwick
Peter Taylor-Gooby - University of Kent
Peter Temin - MIT
Philip Arestis - University of Cambridge
Philippe Martin - sciences po (paris)
Professor Paul Whiteley - University of Essex
Professor Sir Richard Jolly - Institute of Development Studies
Raffaella Sadun - Harvard Business School
Raja Junankar - University of New South Wales, University of Western Sydney, and IZA
Raquel Fernandez - NYU
Richard J. Smith - Faculty of Economics University of Cambridge
Richard Jackman - London School of Economics
Richard Layard - LSE Centre for Economic Performance
Richard Murray - former chief economist, Swedish Agency for Public Management
Richard Parker - Harvard University
Rick van der Ploeg - University of Oxford
Robert A. Feldman - IMF and Adjunct Professor Georgetown U. (retired)
Robert H. Frank - Cornell University
Robert Haveman - University of Wisconsin-Madison
Robert Neild - Emeritus Professor,Trinity College, Cambridge
Robert Pollack - Boston University
Robert Skidelsky - Wawick University
Roger Middleton - University of Bristol
Roger Stephen Crisp - St Annes College, Oxford
Ronald Schettkat - Schumpeter School, University of Wuppertal
Sergio Rossi - Department of Economics, University of Fribourg, Switzerland
Shaun P. Hargreaves Heap - University of East Anglia
Sheila Dow - University of Stirling (emeritus position)
Simon Wren-Lewis - Oxford University
Stefan Szymanski - University of Michigan
Stephen E. Spear - Carnegie Mellon University
Stephen Gibbons - London School of Economics
Susan Himmelweit - The Open University, UK
Terry Barker - University of Cambridge
Tony Venables - University of Oxford
Victor Halberstadt - Leiden University
Wendy Carlin - UCL
William Brown - University of Cambridge
William T. Dickens - Northeastern University and The Brookings Institution


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Recent Comments

  • The world is running carelessly on credit/major risk taking. As a general citizen we are always advised to not get into debt & not waste money or make extreme risks. What are these financial leaders doing breaking all of these rules? We should not get into debt for warfare that is not our own problem, we should not be bailing out banks. The banksters have a crazy monopoly, how is it that they have been allowed to make the most profit ever this year (corporations), while the entire world suffers. What about Glass-Steagall? This would protect us and help us build our economy back up or else the entire globe is headed for financial doom, riots, homeless people, businesses bankrupt etc etc ... is this what the Government wants? Put someone in power that has some sense. I have a degree, but there are no jobs ... get the country back on its feet so businesses can thrive instead of dive!
    Yolanda Goddard
  • I cannot agree more. Let me suggest one thing. I wish you could have included the significance of international policy coordination. Namely, Japan and Germany should be more fiscally expansionary. We are major creditors in the international financial world, after all.
    Tomoichiro Nakamaru
  • Concordo pienamente, le scelte politiche di Merkel & Co. sono sciocche e suicide, per lEuropa, per la democrazia, per leconomia e anche soltanto per il buon senso comune. O costoro sono rimbambiti del tutto o perseguono incoscienti obiettivi opposti a quelli proclamati. E ora di fermarli prima che sia troppo tardi.
    Graziano PRIOTTO
  • Problems cannot even be defined, let alone solved without evidence based analyses. This Manifesto is a step in the right direction. Now, decision makers in Europe and the US need to apply it.
    Andrew J. Esposito
  • The policies of the german government are guaranteeing as the head of the ECB, Mario Draghi, has indicated the most expensive fix to Europes problem possible. This is assuming that the euro currency as a whole remains intact. Forcing the southern tier of euro nations to effectively revise their currency downward through mass unemployment destroys wealth, the productive capacities of nations, and inflicts untold (and unnecessary) human suffering.
    Jonathan Kapiloff
  • Lets be sensible, and stop using politics to solve economic problems.
    Anthony Shreeve
  • Thank you for the manifesto! Sadly, such simple, obvious truths need to be restated in the face of our obtuse policymakers.
    Ignacio Gomez Montejo
  • Please bring the MMT folks into this.
    Burk Braun
  • Rejecting only the comment on Greece
    Dimitrios V. Lyridis
  • There may well be real supply-side constraints waiting in the wings (most likely increasing cost to access oil), but that won be clear until we get demand back on track, so thats the first objective.
    Nigel Goddard
  • A great initiative! But someone should explain this to Angela Merkel rather soon. Hers is the logic of the thrifty "Swabian housewife" (her own words) - with all the catastrophic consequences for Europe and, possibly, the world.
    Tobias Duerr
  • It is important that as many economists as possible sign up to this general statement to make it clear to politicians and policymakers that they do not have our support.
    Ken Coutts
  • Thanks goes out to Paul, Brad for their consistent voices.
    Kevin G Johnson
  • As a German taxpayer, it is distressing to see the dogmatism and lack of debate on economic issues among Germanys leaders. Politicians failure to admit to the citizens the degree to which Germany has profited from the euro is leading to an increasingly populistic tone that is divorced from economic reality.
    Jonathan Schroer, CFA
  • Congratulations on a brief, elegant and lucid account of whats gone wrong with the global economy. The situation is particularly absurd here in New Zealand, where we have one of the OECDs lowest government debt to GDP ratios but a very significant external deficit, driven to no small extent by property investment. We also have weak export growth, negligible investment in r&d and a massive expatriation of skills. Even so, our governments default obsession is with pruning more off its budget, in the apparent hope of impressing the money markets. And this dysfunctional approach still seems to resonate with a majority of voters. Such is the dismal and corrosive power of austeria!
    Ian Morrison
  • It is a mighty task to push through the formidable barrier keeping many elites from reason. Ignorance is one thing. Doggedly holding on to demonstrably perverse notions and falsehoods by those who should know better must be an illness. It is hard to overestimate the power of darkness.
    Dominic Holland
  • This manifesto makes perfect sense. Historically, cutting public spending during a recession does not work as a cure. Given the staggering growth in the divide between the rich few and the rest of us since 1979, current UK economic "policy" is not only wrong, but immoral.
    Ian Stewart
  • The solution to the Latin American debt crises taught us taught us that international cooperation and leadership are needed to find the way out of an obscure tunnel. Brady program brought back the region from the lost decade.
    Victor Peirone
  • While I agree with the broad thrust and purpose of the manifesto, it still, unfortunately, advocates the same neoliberal thinking which caused the crisis in the first place (loanable funds theory, existance of the money multiplier etc.)
    James Davies
  • Thank you, Prof. Krugman and Prof. Layard! We need sound voices like yours in a time of madness and irrationality. I know what Im talking about since I come from the worlds center of economic nonsense a.k.a. Germany. Social Democrats against the Fiscal Compact
    Sozialdemokraten gegen den Fiskalpakt